Back in early June at the OPEC meeting, Saudi Energy Minister Khalid Al-Falih said the global oil market had rebalanced and large stock draws were expected during the second half of the year. He didn’t give any guidance on oil price direction, but the remarks appeared bullish at the time. The oil market had been contending with a large oversupply for some time and prices fell into the $20 range during the first quarter. Both Brent and NYMEX WTI, however, rebounded to the $50 level by early June. Al-Falih’s comments, along with other analysis that the market was in balance, pointed toward more robust prices for the rest of this year and into 2017.

While it may be premature to say prices have already peaked for the year, a sustained bull run for the rest of 2016 looks less and less likely. Activity among hedge funds and other speculators shows fragile conviction for prices to move higher.

But the oil market has regained its bearish sentiment once again, with WTI and Brent falling back to the low $40s, nearing three-month lows. While it may be premature to say prices have already peaked for the year, a sustained bull run for the rest of 2016 looks less and less likely. Activity among hedge funds and other speculators shows fragile conviction for prices to move higher, and it could in fact portend a weaker market. As of July 19, net length—the number of contracts betting on higher prices—in WTI futures and options for speculators stood at just under 156,000, down by 14 percent in just one week. Not only did net length fall considerably last week; the number of players on the short side—those betting on lower prices—rose by an enormous 23 percent, indicating how much market psychology is starting to change. Net length in WTI has fallen by about a third since the end of May, when prices were trending upward toward $50. In Brent, the downward trend is not as stark, but speculators have cut net length by more than a quarter since peaking roughly three months ago.

Glut of products

There’s been a confluence of factors undermining prices and prompting the turnaround in speculator sentiment. Global commercial crude stocks are still at very high levels, making the calls earlier that the market had rebalanced premature. Furthermore, the glut of crude has also moved to refined products. In the U.S., for instance, total gasoline inventories are now at 241 million barrels, up 25 million bbl, or 12 percent, year-on-year. The high stock levels are coinciding with expectations demand will soon wane because of a typical seasonal decline. The distillate fuel market—heating oil and diesel—is also seeing oversupply, with inventories up roughly 6 percent annually at a time demand is lagging year-ago levels, according to Energy Information Administration (EIA) data.

Refined products are on shaky ground, particularly since the markets are heading into the weak demand period between peak summer driving and the winter heating season.

Against this backdrop, speculators are also bearish in the products markets. On NYMEX diesel, net length dropped by some 4,000 contracts last week, as investors took a pause after increasing length rapidly for about four months straight. In the gasoline market, speculators are net long by a meager 1,020 lots, near the bottom of the five-year range. Simply put, refined products are on shaky ground, particularly since the markets are heading into the weak demand period between peak summer driving and the winter heating season.

High OPEC output

OPEC hasn’t necessarily dominated headlines as of late, but its production levels continue to increase even with turmoil still brewing in Venezuela and Nigeria, providing another indicator for weakening prices. “The compelling bearish fundamental surprise here remains the uptrend in OPEC production that is postponing the anticipated rebalancing of the global market, something the market still seems reluctant to acknowledge,” said Tim Evans of Citi Futures in a note.

In June, according to the International Energy Agency (IEA), total crude output from the cartel, including new member Gabon, averaged above 33 million barrels per day, up some 500,000 b/d above year-ago levels. Production levels reached their highest levels since 2008, and volumes from Middle East countries hit a record. Unless there is a complete meltdown in Nigeria or Venezuela, OPEC’s output could keep rising, with Iran determined to keep increasing output to regain market share, Iraq wanting to step up exports, and Libya beginning its long slog to stabilize its resources.

U.S. oil production reaching a turning point?

Adding rigs and increasing production reflect signs of life in the shale patch, but they could further delay the market rebalancing and keep downward pressure on prices. From the industry’s point of view, these trends could be self-defeating.

Recent developments in U.S. production also paint a bearish picture. The country’s oil production has risen slightly for the past couple of weeks to 8.5 mbd, according to preliminary EIA data. While it’s too soon to say whether the output decline that began last spring is over and a rebound is in store, the latest EIA data coupled with the rig rate rising for four straight weeks indicate a possible turning point. The U.S. added 14 oil rigs last week to put the country’s number at 371. Although the rig count has risen lately, it is still down some 44 percent versus the same time last year and off by 77 percent versus the peak in October 2014. Meanwhile, the country’s production is down 1 mbd year-on-year.

Adding rigs and increasing production reflect signs of life in the shale patch, but they could further delay the market rebalancing and keep downward pressure on prices. From the industry’s point of view, these trends could be self-defeating.

“For [some], the rising rig count is an ominous indication that the industry hasn’t learned its lessons from the downturn,” said Jeffrey Spittel and Chris Tucker of FTI Consulting in a new report. “If operators are willing to jump back into drilling with the U.S. benchmark price still below $50 per barrel, the pause in U.S. light tight oil production growth that of late has helped rebalance the market may prove fleeting, with more supply reinforcing the ‘lower for longer’ scenario.”

Even if prices rebound, the industry—and market bulls for that matter—have to contend with more potential supply from drilled but uncompleted wells (DUCs), which can be brought online relatively quickly and in a cost-effective manner. If DUCs are utilized, any rally could easily lose steam.

“If prices creep up past the $50 mark—and stay there—there’s no doubt these DUCs will be converted into active wells,” said Spittel and Tucker. “The only question is the pace at which that will occur. Early indications so far suggest that DUC backlogs are being activated, with independent E&Ps first out of the gate.”

Rebalancing still a ways off

Prices are still a long ways from lows hit earlier this year, but a bear market has certainly returned.

During the second quarter, the oil markets received lifts from talk of an OPEC/non-OPEC production freeze agreement, a spate of supply outages, speculators turning bullish, perceived strength in U.S. gasoline demand, and expectations that the market had rebalanced. Those issues have been turned upside down. OPEC is not freezing output, but instead increasing volumes. The market has compensated for most production outages. Speculators are now getting cold feet and pushing the market downward. The gasoline market in the U.S. is not tight and is instead dealing with a glut. And talk of the market being rebalanced appears hasty. Prices are still a long ways from lows hit earlier this year, but a bear market has certainly returned.

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The Fuse is an energy news and analysis site supported by Securing America’s Future Energy. The views expressed here are those of individual contributors and do not necessarily represent the views of the organization.

Issues in Focus

Safety Standards for Crude-By-Rail Shipments

A series of accidents in North America in recent years have raised concerns regarding rail shipments of crude oil. Fatal accidents in Lynchburg, Virginia, Lac-Megantic, Quebec, Fayette County, West Virginia, and (most recently) Culbertson, Montana have prompted public outcry and regulatory scrutiny.

2014 saw an all-time record of 144 oil train incidents in the U.S.—up from just one in 2009—causing a total of more than $7 million in damage.

The spate of crude-by-rail accidents has emerged from the confluence of three factors. First is the massive increase in oil movements by rail, which has increased more than three-fold since 2010. Second is the inadequate safety features of DOT-111 cars, particularly those constructed prior to 2011, which account for roughly 70 percent of tank cars on U.S. railroads. Third is the high volatility of oil produced from the Bakken and other shale formations, which makes this crude more prone towards combustion.

Of these three, rail car safety standards is the factor over which regulators can exert the most control. After months of regulatory review, on May 1, 2015, the White House and the Department of Transportation unveiled the new safety standards. The announcement also coincided with new tank car standards in Canada—a critical move, since many crude by rail shipments cross the U.S.-Canadian border. In the words DOT, the new rule:

Since the rule was announced, Republicans in Congress sought to roll back the provision calling for an advanced breaking system, following concerns from the rail industry that such an upgrade would be unnecessary and could cost billions of dollars. The advanced braking systems are required to be in place by 2021.

Democrats in Congress have argued that the new rules are insufficient to mitigate the danger. Senator Maria Cantwell (D-WA) and Senator Tammy Baldwin (D-WI) both issued statements arguing that the rules were insufficient and the timelines for safety improvements were too long.

The current industry standard car, the CPC-1232, came into usage in October 2011. These cars have half inch thick shells (marginally thicker than the DOT-111 7/16 inch shells) and advanced valves that are more resilient in the event of an accident. However, these newer cars were involved in the derailments and explosions in Virginia and West Virginia within the past year, raising questions about the validity of replacing only the DOT-111s manufactured before 2011.

Before the rule was finalized, early reports indicated that the rule submitted to the White House by the Department of Transportation has proposed a two-stage phase-out of the current fleet of railcars, focusing first on the pre-2011 cars, then the current standard CPC-1232 cars. In the final rule, DOT mandated a more aggressive timeline for retrofitting the CPC-1232 cars, imposing a deadline of April 1, 2020 for non-jacketed cars.

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DataSpotlight

The recent oil production boom in the United States, while astounding, has created a misleading narrative that the United States is no longer dependent on oil imports. Reports of surging domestic production, calls for relaxation of the crude oil export ban, labels of “Saudi America,” and the recent collapse in oil prices have created a perception that the United States has more oil than it knows what to do with.

This view is misguided. While some forecasts project that the United States could become a self-sufficient oil producer within the next decade, this remains a distant prospect. According to the April 2015 Short Term Energy Outlook, total U.S. crude oil production averaged an estimated 9.3 million barrels per day in March, while total oil demand in the country is over 19 million barrels per day.

This graphic helps illustrate the regional variations in crude oil supply and demand. North America, Europe, and Asia all run significant production deficits, with the Middle East, Africa, Latin America, and Former Soviet Union are global engines of crude oil supply.